How and Why the Buy Side is Changing Its Attitude to High Frequency Trading

Wed, 17 Apr 2013 02:25:00 GMT

An Interview with Remco Lenterman

Since starting HFT Review three years ago, we’ve seen the debate about high frequency trading become in some circles more politicized and more strident, and in others (thankfully) more informed.

In this interview, we speak with Remco Lenterman, Managing Director of IMC Financial Markets and Chairman of the FIA European Principal Traders Association (EPTA), who discusses how and why attitudes to HFT are changing, particularly amongst the buy-side, and who addresses some common criticisms and myths around “quote stuffing”, “rebate arbitrage”, “latency arbitrage” and HFT front-running.

HFT Review: Remco, welcome to HFT Review. Can we start with you telling us a little bit about your own background?

Remco Lenterman: Certainly. I spent most of my career at Goldman Sachs, where I was responsible for trading cash equities in London. I left in 2005 to go back to the Netherlands, where I was involved in a management buyout at a small Dutch investment bank called Kempen. I joined IMC about three years ago. So my background is more on the sell-side, but it’s always been focused around trading.

HFTR: And electronic trading specifically?

RL: Yes, at Goldman I was responsible for setting up their electronic trading business, in 2000/01.

IMC was quite interesting to me, first because it wasn’t the sell-side - which is where I spent most of my career – and second, as a global electronic market-making firm IMC is all about market structure and electronics and automation. And although our strategies are mainly market making, we do trade a range of other strategies as well. In terms of asset classes, we trade equities, options, ETFs, really anything that can be traded electronically.

We now have 550 people worldwide in our offices in Chicago, Amsterdam, Zug, Sydney and Hong Kong. I’m responsible for market structure globally, as well as all the external relationships. As a purely principal trading firm with no clients we obviously don’t talk to the outside world much other than with exchanges, clearing firms and regulators.

HFTR: But you do speak to the outside world in your role as Chairman of the FIA European Principal Traders Association (EPTA). Where does that fit in?

RL: About a couple of years ago, IMC, together with a number of other principal trading firms, felt that we had to do something about the growing amount of negative rhetoric appearing in the media (and as a result, also in the regulatory arena) about firms like ours. It was clear to us that staying silent - which is what many of these firms have always done because they don’t tend to have a public profile - was no longer a viable option. We had to engage both with regulators to influence that debate, and with the outside world in general, to help people understand what we do, the role we play in the markets and the value we deliver. Our industry has suffered from a huge lack of knowledge by the outside world about our activities, which has taken us by surprise (especially the lack of knowledge among other market participants). We realized that a lot of education was needed because many of the problems stem from the fact that what’s unknown is unloved. More to the point, what’s unknown, especially in financial industry, is very quickly put in the realm of abusive.

So in June 2011, we decided to set up the FIA EPTA with several firms. We’ve now grown to 24 member firms.

HFTR: And the group is mainly made up of HFT firms, correct?

RL: It’s a diverse group that engages in a variety of what I would define as generally latency sensitive, highly automated strategies. We don’t call ourselves a high frequency trading group, although in the media we tend to be labelled as an HFT lobbying group. HFT is actually not an entirely correct description, because besides the fact that some of the firms do not have latency sensitive strategies, HFT describes the frequency of transactions rather than the strategy or activity itself.

At IMC, we call ourselves electronic market makers but other firms in the Group are not necessarily market makers. The common denominator is that we are all trading as principal, which is why we decided to call ourselves the European Principal Traders Association. All of the relevant firms in this industry are part of the Group now, and we’re happy that we’ve been able to create a voice for traders to engage with the public and with the regulators.

HFTR: Are you seeing any kind of shift in attitudes towards high frequency trading (or latency sensitive, highly automated trading) as a result of this level of engagement?

RL: Yes, particularly amongst the buy-side. I remember about two and a half years ago, before EPTA existed, several of our types of firms, including Getco and Optiver, organised a round table discussion with the IMA (Investment Management Association). There were probably about 30 buy-side traders there and the reception at the time was pretty hostile, there was a high level of scepticism. But we showed them a lot of data, we explained to them how firms like ours work and the benefits that we bring to the markets, and we discussed our thinking on what efficient markets should look like. And opinions now seem to have shifted. In fact, there was a recent piece of research from TABB Group that showed that amongst the UK buy-side, 75% is now happy to interact with high frequency trading flow.

Some of the buy-side institutions’ perception used to be, “all these guys are sniffing out our order flow and front-running us”, but now it’s shifted to more, “we’re relying on them as principal liquidity providers”. In the institutional block business, institutions have always preferred to trade with other institutional buyers or sellers rather than the brokers’ principal book, they used to call it “trading against the natural”.That’s always been the casesince I started in the business 24 years ago and what we’re seeing today is no different. Clearly if I’m an institution I would prefer to trade with another institution, and the method to do that is by going into a dark pool or going to ask a broker to find the other side, because that limits market impact.

But at the end of the day, there is still a huge reliance for liquidity on the public, lit market because the pure dark pools like the Liquidnets of this world, where there is only institutional business and no broker flow or HFT flow, is just a very small percentage of the market. Institutions realize that the chances of finding the other side for a large block at any particular point in time is always fairly low, so there is a reliance to trade on the public market, where you will invariably trade against our types of firms. And the feature with our types of firms is that, unless we’re doing a particular type of arbitrage, we often want to ultimately sell whatever it is that we’re buying from them, so in that way it’s exactly the same as in the brokerage industry.

The other area where you have seen a clear shift in attitude is on the part of regulators. You now have quite a number of regulators that have studied HFT in depth, the Dutch AFM, the Swedish regulator, the FSA, the Foresight committee on behalf of the UK government and more recently the Australian regulator. Without fail, they all come to the conclusion that commonly held negative perceptions are not substantiated by evidence.

HFTR: That takes us quite nicely onto the question of feedback loops. If there’s a lot of selling pressure coming into the market from institutional flow, which is initially being soaked up by intermediaries such as HFT firms, then obviously those intermediaries will have to offload those positions fairly rapidly in order to stay flat. To what extent does that cause feedback loops in the market, or “mini flash crashes”?